A View on China’s Financial Stability Guarantee Fund – Analysis – Eurasia Review

By Wei Hongxu*

This year, the Chinese government’s work report proposed the creation of a financial stability guarantee fund to guard against systemic risks. This national measure has attracted the attention of many parties. Some parties have different views on resolving the current financial risks of local housing company default and debt reduction. On March 25, the State Council released a government work report titled “Implementation of the Division of Labor in Major Labor Departments.” The People’s Bank of China (PboC) is to take the lead, while the National Development and Reform Commission (NDRC), Ministry of Justice, Ministry of Finance, China Banking and Insurance Regulatory Commission (CBIRC), the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE) are among those responsible for supporting government agencies. They must complete the preparatory work by the end of September while continuing to promote the initiative throughout the year.

A CBIRC spokesperson recently said that the next plan will be to study and improve the relevant regulations and mechanisms for its rapid establishment while accumulating emergency funds for risk prevention. The spokesperson also mentioned that, in preliminary consideration, the purpose of the financial stability guarantee fund is to serve for the prevention of risks presenting hidden systemic dangers. In addition to deposit insurance and industry guarantee funds for risk prevention, the financial stability guarantee fund is indispensable for protecting China’s financial safety net. The financial stability guarantee fund must be differentiated between industries and entities with corresponding burdens to balance risks, benefits and responsibilities and at the same time prevent any possible loss to the government and taxpayers.

As of now, the objectives, reasoning, goals and principles of the financial stability guarantee fund, as well as a precise timetable, have been established. A comprehensive plan for institutional settings, funding sources and uses of funding is still available. ANBOUND researchers believe that despite the clarification of the policy framework, the financial stability guarantee fund is still not properly planned and organised. Constant deliberation and change could place the financial stability guarantee fund in uncertainty.

First, the objectives of the financial stability guarantee fund should be clearly understood. From the point of view of institutional frameworks, there is the leadership of the PBoC with the participation of several bodies. It seems that risk prevention objectives would be associated not only with the banking and insurance sectors, but also with non-banking financial institutions, such as trust companies, leasing entities, payment institutions and capital market institutions such as fund management companies and securities companies. This is in line with the objective of the financial stability guarantee fund to prevent risks in the financial system. Currently, financial institutions such as banks, insurance companies, trust companies and brokerage houses have acquired risk mitigation mechanisms such as deposit insurance. Local credit risk funds have also been created by some local governments. The governing bodies may wonder whether the establishment of the financial stability guarantee fund does not come into conflict with the existing mechanisms for the prevention of financial risks. Another question to consider is whether the financial stability guarantee fund should act as a last resort risk shield or as a precursor intervention for risk management. The positioning and responsibilities of the various risk prevention mechanisms must also be clarified.

In terms of operation, some research institutions believe that the European Financial Stability Facility (EFSF) can serve as a model for a market-oriented risk prevention mechanism. Considerations for the operation of such funds include, first, appropriate market intervention in the event of financial risks; second, preventive action plans; and third, the provision of funds for the recapitalization of financial institutions. Some of these responsibilities overlap with those currently held by China’s central bank. Once systemic risks have emerged and spread through the financial market, the central bank will always act as the “borrower of last resort”. Accordingly, more research should be conducted to determine the feasibility of the European financial stability policy model. Finally, the establishment of the financial stability guarantee fund mainly serves as a capital reorganization investor in the post-event risk prevention phase, which is not entirely in line with the principle of risk prevention centered on the market. If the sole purpose is to raise funds to prevent systemic risks, inseparable from the strong intervention of the financial supervision department, then the financial stability guarantee fund cannot fully reflect commodification.

The authorities responsible could also wonder about the source of financing of the national risk protection fund and the methods of its allocation. Current information shows that it could be financed by market financial institutions according to the deposit insurance fund model. The market is very concerned about whether the financial stability guarantee fund will participate while wondering whether local finance will inject capital. With regard to the market’s current worries about the defaults of real estate companies and the resolution of implicit local debts, the market expects a lot from the financial stability guarantee fund. The market believes that the intervention of financial funds, particularly with the intervention of local finance, could help eliminate these long-term risks.

For the ANBOUND researchers, the financial stability guarantee fund is not comparable to a global market-oriented risk response institution. The financial stability guarantee fund has a political role that public finances should serve as a high probability choice to avoid any embarrassing condition caused by the trust protection fund. However, there is still no conclusion on whether local financial institutions or governments should contribute capital. The decision to apply funding for risk protection also remains unclear. The concern would need to streamline the tax system between central and local governments to avoid more new local debt. Under the current conditions of risk prevention, failures of local companies mainly concern financial institutions and local authorities. The financial stability guarantee fund is likely to present itself as a protection mechanism against local and regional risks, which means that local and regional financial risks must be prevented rather indirectly. Local governments will continue to manage regional risks and territorial responsibilities.

The market is most concerned about the financial stability guarantee fund, in particular the types of risks that could be considered systemic risks and the types of institutions that will be targeted by the fund. Another concern is whether it should directly target domestic financial institutions to manage market entities, or conduct market interventions depending on the scale of risk exposure. These issues still need to be clarified by financial regulators. It should be noted that the creation of a financial stability guarantee fund cannot avoid the “too big to fail” surge of interest from commercial and financial institutions. Bailouts, interventions, prevention of risk contagion and prevention of moral hazard in financial institutions are some of the challenges that the financial stability guarantee fund may encounter in the future. All this requires constant adjustment and adjustment of financial regulatory policies.

*Wei Hongxu, ANBOUND researcher, graduate of Peking University School of Mathematics and PhD in Economics from University of Birmingham, UK

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